For many years, pundits have predicted the demise of paper money. It turns out they were right, but not in the way they expected. The Bank of Canada is replacing the old paper bills with new high-tech polymer notes, to the irritation of people who have trouble counting the slippery new twenties and fifties.

The prediction that cash money would be entirely replaced by electronic means of payment has failed to happen. Cash money, whether made of polymer or paper, appears to be thriving.

Some interesting insights into the use of various forms of payment can be gleaned from a recent Bank of Canada report. The bank sent out questionnaires to several thousand Canadians to elicit information about how they pay for the things they buy – cash, cheque, credit card or debit card.

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Anybody who has stood in line at a cash register knows that the use of credit cards and debit cards has become pervasive. This is confirmed by the bank's survey. Credit cards were the top means of payment, accounting for almost 41 per cent of the value of spending, followed closely by debit cards with 32 per cent, while old fashioned banknotes (cash money) were a distant third at 23 per cent.

The survey asked people how much cash they have on hand, and the average amount was about $310. Multiply that by the number of Canadians, including a guesstimate for people outside the survey's age range, and it implies that total cash holding amounted to about $9-billion in total at the end of 2009, when the survey was done.

That leaves quite a mystery about where all the cash is – because the Bank of Canada knows the value of all the cash it has printed that isn't held by banks, and that's $55-billion. Some of this cash may be outside Canada, but Canadian currency is not widely recognized or used as a store of value outside Canada, as the U.S. dollar is.

In the accompanying chart, the past three decades of history is shown for a particularly interesting statistic, which is the ratio of the currency outside banks to weekly consumer spending.

The Bank of Canada report noted that back in 1990, about 50 per cent of the value of transactions was cash. One would expect that the amount of cash in circulation has gone way down relative to spending, but the reality is anything but. Far from declining relative to 1990, this ratio is much higher in 2012.

This ratio fell steadily through the 1980s as financial innovations, such as credit cards, reduced the use of paper money. It shot up after 1991. Some analysts have attributed this to the introduction of the Goods and Services Tax (GST), and the encouragement it gave to the underground economy. Quite remarkably, it has remained on an upward trend since then, in spite of the large decline in the use of cash for regular transactions.

The ratio is very high, given that the largest components of consumer spending (mortgage payments, rent, property tax, utility bills) are rarely paid for in cash. Hardly any employees are paid their salaries in cash anymore (unlike the early part of the 20th century, when crime films used to feature payroll robberies), and cash is rarely used by major companies in legitimate business-to-business transactions. It is hard to resist the suspicion that a substantial reason for the persistence of cash is its popularity in the underground economy, where it is preferred because it does not leave an audit trail.

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In the survey, the bank asked people why they use a particular means of payment, and "ease of use" was the top reason for using cash. "Ease of use" is as good a term as any, as apparently "tax evasion" and "underground economy" were not options that respondents could choose.

Of course, one has to take the results of any such survey with a grain of salt, as many people are going to be shy about admitting an illegal activity to a government agency, even if it's not the Canada Revenue Agency. An interesting test was conducted by researchers studying the underground economy in Norway. They did two surveys, one where the respondents were known (as in this one, drawing on a regular panel run by Ipsos Reid) and another one that was completely anonymous. In the latter, the percentage of people admitting to tax evasion was about double.

The report by economist Don Drummond to the Ontario government last year noted the problem of the underground economy and the revenue losses it causes for governments. It urged more stringent auditing and better data gathering, including the use of "wealth indicators" to detect cheating by people whose assets cannot be properly explained by their reported income.

The evidence from the amount of cash is just one indicator suggesting that the underground economy may be continuing to grow in Canada. This is a problem that fiscally challenged governments need to look at more closely.

Peter Spiro is an economic consultant and Executive Fellow at the Mowat Centre for Policy Innovation at the University of Toronto's School of Public Policy and Governance.

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